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Portfolio Review
Equity markets during the second quarter experienced more selling pressure as the S&P 500
declined by almost 3%. The equity portion of the Rorer Balanced Portfolio, however, turned in a
positive performance, thereby substantially outperforming the benchmark. This performance was
almost entirely due to good stock selection rather than from sector bets. In fact, the Rorer
Balanced Portfolio had positive stock selection in almost all of the S&P 500 sectors. Two of the
best-performing sectors, on a relative basis, were industrials and financial services. Joy Global,
which manufactures and services mining equipment, was a standout performer in the industrial
area. As the price of oil climbed throughout the quarter, investors became ever more interested in
other sources of energy, such as coal and the companies that supply the coal industry. In the
finance area, Goldman Sachs and TD Ameritrade were actually up in the second quarter, even
though the financial sector was the worst-performing sector in the S&P 500. Both of these
finance companies essentially escaped the carnage of the sub-prime and credit crisis that haunted
the financial sector during the quarter. Two stocks that did not perform well in the quarter were
Valero Energy and Lehman Brothers. Valero, which refines and markets crude oil, suffered from
margin compression concerns as the price of crude oil rose through the second quarter. Lehman
Brothers, in which we purchased a partial position during the quarter, suffered from credit
concerns along with most of its peers, and we sold the partial position due to our stop loss
discipline.
Market Review
During the second quarter, equity markets fell due to continued concerns about the credit crisis,
the U.S. housing market, and a potential recession. In fact, the broad equity market, as defined by
the S&P 500, was down almost 3% in the quarter. Housing prices in the U.S., which started to
fall last year, continued their decline through the second quarter of this year. Problems in the
sub-prime real estate market, which surfaced in the third quarter of last year, have grown at a
meaningful rate. Global financial firms have now written off close to $300 billion due to the
housing meltdown, and the losses are still growing. The best-performing sector in the S&P 500
in the quarter was energy, helped by the price of crude oil reaching all-time highs. The worstperforming
sector was financial services, which was negatively impacted by the housing market
and credit problems.
At Rorer, we feel strongly that the recent market weakness presents patient investors with many
extraordinary opportunities to own quality stocks that are levered to strong long-term demand
trends, at attractive valuation levels. While the Fed’s actions to lower interest rates and support the mortgage market serve as confirmation that the risk of slowing U.S. growth outweighs the
perceived risk of inflation, we believe that these actions also signal a critical commitment to
stabilizing the U.S. capital markets. As the impact of these and prior policy actions filter through
the system, we think investors will begin to look toward a period of better growth. Meanwhile,
even as we anticipate a better economy next year, unemployment remains modest, wage growth
is contained, international corporate and consumer spending trends remain positive, and
corporate earnings - outside of financial and consumer-discretionary companies - are performing
well. Taken together, the backdrop of what we believe is a temporary decline in stock prices and
a favorable monetary policy should prove advantageous to the Rorer investment process. In fact,
the recent pullback has allowed us to initiate new positions in many stocks that previously did
not meet our strict valuation parameters. We believe our emphasis on high-quality companies,
trading at low relative valuations, will help us to continue outperforming the market in the years
ahead.
Trading Activity
Trading activity was slightly heavier than normal during the second quarter due to the volatility
in the marketplace. During the quarter we initiated new positions in Apollo Group, Time Warner,
Lehman Brothers, Eaton Corp, and ConAgra; we also added to our positions in Nabors, Tyco,
Lowes, Legg Mason, Cognizant, and JPMorgan. On the sell side, we sold Manpower as a source
of funds. Our stop loss discipline trigged sales in Hologic and Lehman Brothers. In addition, we
scaled back our position size in a number of holdings, including Halliburton, Caterpillar, Express
Scripts, Devon, Joy Global, Linear Technologies, and Corning.
The bond market, as measured by the Lehman Brothers Intermediate Government/Credit Index,
fell -1.5% during the second quarter. Yields were higher by 50 and 90 basis points (0.50% and
0.90%), respectively, for the ten-year and five-year sectors of the Treasury yield curve. Thanks
to issue selection in our corporate bond exposure, which focused on quality and liquidity, the
fixed-income portion of the Rorer Balanced Portfolio outperformed the Index during the quarter
and particularly during June, when higher-quality sectors handily outperformed their lower-rated
counterparts. In addition, throughout the quarter we maintained an average duration that was
neutral to defensive relative to the Index. |
